Levers of Wealth, Part 3: Saving

In the second part of this series, we looked at the impact of ROI on your investments. In this article, we turn our attention towards the second lever, i.e. how much you save and invest. We will look at the impact of your savings on investment, the difficulty in doing so, and how it compares with other levers.

To recap, these are the levers. We are looking at the highlighted lever in this article.

Why save money?

Given that our first money lesson is about saving, some may find it unnecessary to explain its importance to those building a retirement corpus. But those investors are the ones who need it the most, as we will show later in this article. 

After all, many investors spend a good part of their waking hours going through scheme documents, headlines, economic indicators and much more just to tweak their portfolio and squeeze a little extra ROI. If only they paid attention to what they do with money, they would get back more than just ROI.

To quantify the impact of saving on ROI, we will go back to the example of 30-year-Rajesh who is a husband and father of a young child. This is where he currently stands financially.

Salary = 9 lakhs per annum 

Increment = 10% per annum

Previous Balance = Rs. 4 lakhs

% of salary invested = 40%

ROI = 7.5% post-tax, a little above the inflation rate of 7%

Applying Lever 2: Saving & Investing

We will study two variations of the same lever

• Lever 2.1 - Increase annual savings rate of 40% by 2% annually, until a maximum of 66% or two-thirds of salary is invested.
• Lever 2.2 - Increase annual savings rate of 40% by 3% annually, until a maximum of 70% of salary is invested.

Before we look at the numbers, here are a few things to note - 

1) Rajesh is the sole earning member of his family of three which includes his wife and a three-year-old. 

2) The aim is to build an inflation-adjusted portfolio of Rs. 2 crores and retire at the age of 50, i.e. 2039. Anything that doesn't add to this portfolio is an expense, be it EMIs, insurance premium, or even investments for goals like children's education and wedding.

3) Savings made in a year -- for example, 2020 -- will be reflected in the investment for next year, i.e. 2021.  

So how does increased saving impact the portfolio?

As given in the table below, a little extra saving every year eventually increases the portfolio by around 50% over 20 years.

Graph 1
*All figures in lakhs

Table 1 - Impact of saving more

*All figures in lakhs

The year-on-year growth in savings and portfolio is given in the table below. If you want to see a more detailed version, click here to see the calculation for Lever 2.1 and here for Lever 2.2

So what makes saving hard?

We have considered the example of Rajesh, a 30-year old married man and a father of a three-year-old. His salary (which grows at a fixed 10% annum post-tax) has to cover the increase in cost of living (growing at 7% per annum), increase in investments (growing at 2% per annum), as well as the growing needs of his family. Of these, the last one includes children’s education and wedding,  annual vacation, social gatherings, and other such expectations.

As always, the best way is to understand these through numbers. Since Rajesh invests Rs. 40% of his income, let us assume that he needs 60% (or Rs. 5.4 lakhs) to meet all the expenses in his first year. If we consider inflation to be 7%, he will need to reduce his expenses every year to accommodate his growing investment. The table below shows how much he will have to reduce it every year.

Table 3 - Compare the Cost & Budget under each Lever.

*In 2020, Rajesh has an opening balance of Rs. 4 lakhs

** All figures in lakhs

Observations

1. As long as the share of salary invested rises, so does the gap between the cost and budget. From the second year, the budget is always lower than the cost.

2. Usually, people invest whatever remaining after their expenses. But since the investment is rising, this will require you to invest first and spend whatever remains.
   
   

Returning to our original question, long-term saving is the hardest among all three levers because it requires the deepest behavioural change. The money you save and invest is simply the sum of all spending decisions made by you and your family. In contrast, the growth of your salary or ROI may depend on a few smart decisions.

If it is so hard, why do it?

Because among all things that decide your portfolio, your saving is what you control most. Your ROI and your salary depend on the national economy whereas what you save is your personal economy.

For example, India’s most valuable stocks have lost value in the Covid-19 economic crisis while the brightest among our workforce have seen layoffs and pay cuts. But since spending lies at the centre of one’s personal economy and sphere of control, the impact of any decision is immediate. To illustrate, when you postpone your wardrobe upgrade and invest the money, the impact to your portfolio is immediate. And when that amount fetches interest, the impact is recurring. 

In the final article of this series, we look at the impact of your annual income and compare all three levers on their impact on your portfolio.

Other articles in this series

• The Levers of your Wealth - Part 1
• Levers of Wealth, Part 2: ROI